CFD Trading for Dummies (Everything Explained)

In the world of trading, the “survival of the fittest” rule applies. And being the fittest translates by being the most knowledgeable and most adaptable of all. I say this because today we will be dealing with CFDs (Contract for Difference) and, in order to understand what it takes to make it big into the industry, we need to go right back to the roots.

CFD trading is different than traditional methods by the fact that it is a system that is easier to get acquainted with and it is overall more suitable for novice traders, who don’t want to risk too much of their money.

The basics of CFD trading

There are several things that are unique to the CFD trading system, compared to the traditional one:

With CFDs, you know ahead of time what your profits, as well as your losses, are going to be

They function based on leverage, which is using a small personal capital, and borrowing the rest, to control a high value position

The margin is a certain amount of money (a percentage of the asset’s value) you need to invest in order to control the high value position

There is a relation of interdependence between the value of the margin and that of the leverage; the lower the margin, the higher the leverage and vice-versa

The less you invest, the higher the potential return rate is and there is basically no limit to how much you can gain, even with minimum investments

The losses can be equally devastating if you ignore the leverage effect going against you

What you see here are some of the basics you need to have in mind. But, just to get it out there right from the get-go, you must know that CFD trading is easy, but risky. All trading is risky, if you think about it. But that risk is multiplied by how the leverage works.

And for a better understanding of the whole concept, there are several aspects we have to break down:

How does CFD trading works?

The benefits and the risks

The best money making CFD strategies

How to improve your game

With this in mind, let’s start with the first section:

How does CFD trading work?

For both experienced traders, coming from the traditional school of trading, and beginners alike, who have no idea of the principles of trading in general, CFDs may seem a bit confusing.

This is because it is their simplicity that throws people off. And that simplicity refers to 2 different aspects:

The system itself is easy to understand

It has a high predictability power, thus, making it highly effective

Regarding the first point, all you have to do is to understand the basic notions. What is a margin, what is a leverage, what is a spread and how they function as part of the system.

When it comes to the second point, however, I think the best way to explain it is to resort to an example:

We have John. John is a novice trader, looking to jump on board the CFD train, without knowing too many advanced strategies. He checks the market and spots Nokia announcing a huge breakthrough in the software department, working on a revolutionary social recognition app.

The app is set to be released 1 and a half months for now. John immediately realizes that the Nokia shares will grow considerably over the next period, so he decides to invest. Nokia shares are worth $4.92 each and John decides to buy 1.000 of them. That would be $4,920 investment.

And, with a margin of 10%, all he is investing is $492. The rest of $4,428 is borrowed from the broker. The leverage is 1:10, meaning that for every dollar invested, he will get $10 back. His bet is that, in one month time, the shares will grow to $5.2.

One month passes and the shares are now worth even more – $5.4. John sells his 1.000 shares and gets $5.400 back. His invested margin of $492 is still in his account, and all he has to pay now is $4,428 to is broker – the amount he borrowed. Plus minor spread fees, let’s say $22.

What he will be left with is $950 pure profit.

In John’s case, he didn’t need to know highly advanced trading strategies. And, furthermore, John knew in advance how much money he will be making, as a minimum, if things went the way he predicted.

Because he predicted that the shares will go to $5.2. And it is this prediction capability that makes the CFD trading business so appreciated among traders. The way the system works is as easy as it can get, also.

The benefits and the risks

Everything in this section has to do with the leverage. Leverage is both the great provider and the great destructor, especially when people treat it lightly. The leverage is used to multiply the gains. In John’s case, the leverage multiplied his gains 10 times, allowing him to make a lot of profit as a result. Now, consider the fact that some assets allow leverages of up to 1:500 and you can get the overall picture I am trying to draw here.

With this being said, here are some benefits and risks you need to keep in mind.

Benefits

An easier to understand system, compared to traditional trading

Less money required to invest

The return rate can be multiplied by up to 500 times

No limit to how much you can win

Predictable income

A higher degree of control on the outcomes

More profitable during short-term trades than traditional trading methods

Risks

The risk of losing more than you can afford, because of the leverage

I want to say something about the leverage here. A 1:10 leverage means 2 things: you will either win 10 times what you have invested, or lose 10 times over. This is why it is essential to resort to specific strategies to prevent that from happening. Because you can.

The best money making CFD strategies

Some of the best CFD strategies you can use for CFD trading include:

Always go for safe bids – If you are not sure of the outcome, better avoid the trade

Avoid volatile assets – The more volatile they are, the higher the chance for the unexpected to happen

Use stop-loss and limit-profit orders – These will make sure you will minimize the losses and secure the profits at the same time

Always analyze the market – By doing so, you will never be caught off guard

Always improve yourself – Seek and adopt only those trading strategies that have proved to work in the past

These are just some of the basic strategies you need to adopt. As you progress, you will quickly discover others more effective, more complex and more versatile that you can use to increase your chances of winning.

How to improve your game

I never got to hear a professional trader claiming he had it all figured out. As long as you will be in the trading business, you will always have something to learn. And, in the end, this is the key to becoming better – if you want to learn CFD trading and improve on your game, you need to be able to:

How does CFD trading work? How to trade CFDs? - The complete answer to these questions can be found in this comprehensive guide. Learn everything that there is to know about CFD trading and CFD trading strategies.

Learn everything about the costs and commissions that you may incur in CFD trading and how all these affect your breakeven and profit margins. Find out what CFD brokers don't have any commissions at all.

Learn about the risks of CFD trading so that you are aware of the potential losses that you may incur in case of unsuccessful trades. Understanding these risks can greatly help you in decreasing and even preventing such losses.

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